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Do falling markets spell doom for responsible investment?

No, says Australia’s Louise O’Halloran, because correlations between returns and ESG issues are becoming obvious and quantifiable.

There is no doubt that in the past it’s been harder to sell the concept of responsible investment when the markets are down. Interestingly, the research tells us that those already invested in the area are much more likely to stay with their responsible investments through tough times, but it is certainly more difficult to attract the attention of new investors.
I think the reason for this is that for many years now responsible investment practices have been falsely associated with compromised returns. While the bulk of research reports show strong correlations between the financial performance of companies and their corporate responsibility practices, the markets have been somewhat sceptical about whether or not these correlations can really be quantified. But now all that is changing and I do believe that with this imminent downturn, we are more likely to find investors moving toward rather than away from responsible investment practices. And the reason is that the correlations are becoming so obvious and so quantifiable.
The sub-prime collapse is a timely example. Leading responsible investment analysts documented a host of market failures associated with the mortgage market inthe United States in August 2006 and then predicted the sub-prime collapse a full ten months before it occurred. How did they do that? At the time they were in the process of examining predatory and opportunistic lending practices by retail banks.
That’s the “S” in ESG. They observed that sub-prime loans had increased from 6% to 40% between 2003 and 2006. Further research showed that it was highly unlikely that this amount of sub-prime lending would ever be repaid. Why? First, because real wages had been stagnant since 2000. Second, because household savings rates had been plummeting for a decade. Third, because housing prices were not rocketing ahead as these sub-prime lenders were led to believe. It’s case studies like this that show how incredibly appropriate responsible investment analysis is if we want to really understand the world. Another reason that I believe this downturn will swing people’s attention toward responsible investment is that a raft of regulations are now emerging which will force companies to absorb costs which had previously been absorbed by governments or individuals. Carbon pricing is one example, but there are many others as well, such as

increasing regulation associated with waste, site contamination, toxic products, foodstuffs which lead to obesity, the list is long. Once those price signals are factored into company valuations we are sure to see a greater interest from analysts on issues which may not beapparent on a spreadsheet, but nevertheless have serious financial consequences.
Louise O’Halloran is the Executive Director of the Responsible Investment Association Australasia
This article first appeared in Responsible Investment News, Australia: